Years ago, a 20% down payment was a requirement for obtaining a mortgage loan. Putting that much money down made it less likely that borrowers would simply default on their home loans and gave lenders a measure of security and collateral in the case of foreclosure.
However, in more recent years, lenders have gotten much more creative in financing to help more Americans become homeowners. There are now mortgage loans that require as little as 3% down up front. In order to compensate for that added risk of loss, lenders require and borrowers with a down payment of less than 20% to pay for private mortgage insurance (PMI).
PMI is an insurance policy that the borrower takes out with a separate company that guarantees the mortgage company will recoup their losses if the borrower defaults. The borrower pays a premium each month and must keep the policy until his or her equity reaches 20% of the home value.
If you are in the market for a home loan but are not sure you can scrape together a large enough down payment to avoid PMI, here are 4 reasons you should think about saving a little longer:
Of course, there may be some situations when paying PMI makes sense. Most often this is when you are buying in an area with strong home price appreciation or if your down payment is very close to 20% and you know you will be able to put down the rest soon. And first-time homebuyers often find PMI worth the cost in order to break into the housing market.
However, in most other situations, simply saving up a full 20% down payment is the safest way to take on a mortgage home loan. It also ensures that you let your money work for you and not the other way around.